Texas vs. California (Part 3)

This is our third installment in a series discussing Texas and California. We have written about why businesses and individuals seem to be leaving CA for TX. One in five Americans calls California or Texas home. The two most populous states have a lot in common: a long coast, a sunny climate, a diverse population, plenty of oil in the ground, and Mexico to the south. Where the states really diverge is in their governance.

Let’s look at population, GDP, and the states’ respective budgets. We will use budget data from the Census Annual Survey of State Government Finances and job and per capita income data from the Bureau of Economic Analysis.

Last year (2012), California had a population about 30% larger than Texas, a deficit 210% higher, and state debt 380% higher. It’s safe to say that low-tax Texas appears to be in a better fiscal shape.

California earned the name “The Golden State” and adopted the motto in 1968. The nickname’s origins are from the discovery of gold in 1848, and the expansive fields of poppies and many opportunities present in the state. In 1950 the Golden State had 40% higher per capita income than Texas. In 1970, the advantage was still over 30%. By 2009, the difference had shrunk to only 10%, without taking into account the higher cost of living in California.

As we have discussed the last couple of weeks, it appears that Texas is doing better than California not only fiscally, but also in terms of aggregate job and income growth.

One thing I would warn about is exaggerating California’s debt problem. It’s true that they have mismanaged their finances, and expanded government seemingly beyond what they can afford. However, California is still extremely wealthy, with a total GDP of about $1.8 trillion dollars in 2011. This is bigger than Brazil and Russia ($1.6 trillion) and almost as large as Italy ($2.3 trillion). Texas is $1.2 trillion in comparison. So while their tax base may appear narrow, their entire economic base is very wide. The debt to GDP ratio for California alone is still below 10% (or 80%, if you add the national debt).

Also, let’s not make too strong policy-inference from the short-term (less than ten years) mortgage-bubble that is currently distressing California. Policy should be based on evaluations of long term performance. We would argue above that the long term trend also favors Texas.

There are many other reasons why Texas is thriving while other states flail.

Rising oil prices

A boon for Texas, California not so much.

In 2012, the Brent crude oil spot price averaged $112 per barrel, and rose to $119 a barrel in early February. Even though we have seen an unexplained surge at the pumps lately, the Energy Information Administration is projecting an average price of $109 a barrel. Crude prices peaked at $134.02 per barrel in June 2008. Those rising oil prices may have been bad news for drivers, but they helped out the Texas and California economy, which rank #1 and 3 respectively in oil output.

When oil prices are high, job growth in Texas historically has exceeded that of the nation. Texas entered the recession late and came out early, mirroring trends in oil prices, which rose towards the beginning of the recession, fell in 2009, but have been steadily rising since.

The states that are expanding economically are almost all energy states. Based on Dallas Federal Reserve research, a 10 percent increase in oil prices leads to a 0.3 percent rise in employment and a 0.5 percent rise in GDP for the state of Texas.

One of the big differences between the two states has been the introduction of fracking. New recovery techniques, such as steam injection and later hydraulic fracturing (fracking), changed the industry and lessened our reliance on other countries oil production. A decade ago, Texas oil engineers decided to combine horizontal drilling with a process called hydraulic fracturing, which injects chemical-laced water into the shale to push out the minerals. The system has been effective in releasing previously untapped pockets of natural gas in shale formations, such as the Eagle Ford shale formation in South Texas. In 2000, 1 percent of the U.S. gas supplies were from shale, but now the figure is 25 percent. And as a result of the new technology, Texas is home to some of the most prosperous new oil fields in the country.

Fracking has opened up the Eagle Ford formation to tremendous economic opportunity. This region of south Texas was a sparsely populated area that has not historically been very economically strong. Fracking has breathed new life into the area and has not only brought jobs but has also created a new set of millionaires whose land has sky rocketed in value.

In California, fracking has kept older fields open, particularly those in Kern County, and has preserved CA’s place as the nation’s third largest petroleum producer. But to this point, fracking has not been used for new fields due to environmental and regulatory concerns. Meanwhile, oil production is booming in other states, principally North Dakota and Texas, due to extensive use of fracking to tap into deposits in shale — so much so that the U.S. may soon become an exporter again.

But what about California? It’s been estimated that deep shale deposits in California, particularly those along California’s Central Coast and in the Central Valley, contain as much as 400 billion barrels of oil, equivalent to half of Saudi Arabia’s oil fields. But whether California experiences a new oil boom similar to one it saw in the early 20th century depends on whether the state’s extraordinarily sensitive environmental conscious can tolerate more fracking, particularly along the coast.

So will California see a new oil boom? Not immediately, but the potential is there to help improve a somewhat stagnant economy, create many thousands of jobs, and pump billions into state and local government coffers. The question is at what cost?

Housing costs

Texas has been referred to as one of the remarkable economic stories of the last decade. But its growth isn’t due to the wealthy fleeing to places with the lowest tax rates. If you look closer at the data, the people moving out of the state are wealthier than those moving in — so the lower housing costs and living expenses in Texas is a major magnet.

We all are aware of the ramifications of runaway real estate appreciation. From 2000 to 2006 as California experienced over 250% appreciation of real estate assets (Source: OFHEO). At the same time Texas was 50th in appreciation with less than 3% annual appreciation annually.

This lack of appreciation in Texas helped the state escape the foreclosure bust that crippled other states’ economies —less than 2 percent of Texas mortgage borrowers are in or near foreclosure, according to the Mortgage Bankers Association, while the national average is nearly 10 percent. States like Arizona, Florida, and Nevada faced mortgage borrower foreclosure rates of 13, 12, and 19 percent, respectively, in 2012. Texas’s relatively stable market may have been a factor in preventing housing prices from climbing. California and Nevada have been helped by investors shoring up prices. As of December, 10% of Florida’s home loans were still in some stage of foreclosure, the highest percentage in the nation. Behind it were New Jersey (7%), New York (5%), Nevada (4.7%), and Illinois (4.5 percent), according to CoreLogic. Among the five, only Nevada is a non-judicial foreclosure state.

Some credit Texas’s stability to state regulations on cash-out and home equity loans, which don’t allow borrowers to take out loans that total more than 80 percent of a home’s appraised value. California, Florida, and many other states had a run of 100% refinances with borrowers sometimes refinancing two or three times in a couple of years to retrieve money from their over-appreciated homes. These cash-out loans allowed borrows in other places to refinance their homes for more than their original mortgage value — driving up home prices and contributing to the eventual burst of the housing bubble.

Another factor in Texas that prevented housing prices from rising dramatically during the housing boom is the abundance of cheap, open land and easier building regulations. Look at land values on both coasts as well as the length of the entitlement process (the process from purchase through engineering to the start of development). 6 months to 2.5 years in Texas is a walk in the park compared to 7 to 10 years in California, Florida, Arizona and other ‘boom’ states.

Affordable homes are one of the key reasons Texas continues to thrive. The California average home price is $738,526 and the median price is $452,000. Texas is significantly less expensive with a $283,137 average price and a $144,900 median price. Affordable land and limited municipal and state regulation allow for less expensive homes. In Texas the cost of the home is traditionally 5x the price of the lot, or 3x the price of the lot in more desirable areas. In California, it is the opposite, where the land is typically the largest cost.

Cost of labor

Immigrant workers make up the majority of migrant farm workers in places such as California’s Central Valley and southern Texas doing seasonal work such as fruit picking and sorting. Seventy five percent of crop workers in certain areas are from Mexico and about half are undocumented, according to a 2011 U.S. Department of Labor survey. Immigrant workers make up a vital part of the construction workforce. In California, Nevada, Texas and Arizona, it is estimated a third of all construction workers are immigrants. Twenty percent of construction workers nationally were born abroad. Of these figures, more than half came from Mexico and another 25 percent from Latin American countries.

Both states have a pool of cheap, unskilled labor. However, skilled labor is another story. Businesses are moving away from areas with a high concentration of unionized skilled labor. As Dr. Mark Dotzsour from Texas A&M said, ‘Let’s face it. Employers come to Texas and other southern locations because they feel that they can make a higher profit. Taxes are a major consideration. So is the cost of labor. Clearly businesses are moving away from areas with a high concentration of unionized labor.’

The Bureau of Labor Statistics puts out information about the percentage of all workers in each state that are represented by a labor union. Here are the states with the highest concentration:

• New York, 24.9%

• Alaska, 23.9%

• Hawaii, 23.2%

• Washington, 19.5%

• Rhode Island, 18.4%

• California, 18.4%

• Michigan, 17.1%

• New Jersey, 16.8%

• Massachusetts, 16.2%

• Illinois, 15.5%

Here are the states with the lowest concentration:

• Arkansas, 3.7%

• North Carolina, 4.3%

• South Carolina, 4.6%

• Georgia, 5.4%

• Virginia, 5.5%

• Minnesota, 5.7%

• Tennessee, 5.9%

• Texas, 6.8%

Many companies like the flexibility associated with the ability to freely make decisions without the pressure of a union, so states with a low percentage of a unionized private sector labor force ranked near the top for many business owners and CEO’s. That coupled with a lower cost of living for a company’s workers has made moving companies to Texas more attractive.

The ability to make money motivates workers, suggesting an advantage for places with higher pay. The nation’s leaders in earnings per job were found in the Northeast, led by New York, Connecticut, Massachusetts and New Jersey. California, on the other side of the country, comes next. These states lost some of their appeal because steep living costs and taxes ate into the higher pay. Texas, a state with low living costs and taxes, ranked a respectable 13th in earnings.

As we have discussed the last few weeks, both states (California and Texas) have their strengths and weaknesses. Each has had their chance for their day in the economic sun. The question is what will the next decade bring? The strength of less regulation and lower taxes or the need for more government services? California’s habit of raising taxes to fund a burgeoning regulatory state isn’t without impact on its economy. Californians fork over about 10.6 percent of their income to state and local governments, above the U.S. average of 9.8 percent. Texans pay 7.9 percent. This affects the bottom line of both consumers and businesses.